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Coastwise Monthly Dividend Newsletter January 2017

Dear Coastwise Community,

 
Welcome to the monthly Coastwise Dividend Newsletter where we muse on financial matters that impact your wallet and your life.
 
 
"May you live in interesting times." - Ancient Chinese Proverb
 
 
Understanding Risk
 
Regardless of which side of the political spectrum you land on, we can all agree we live in ‘interesting’ times. Such turmoil and uncertainty, regardless of source and nature, tends to cause market volatility. Many so-called investment professionals see volatility as a source of risk. One of the main questions asked of clients relates to how much volatility they can tolerate. But this is examining the very wrong thing when it comes to constructing an investment portfolio.
 
If your time investment horizon is short (e.g. months rather than years), then day-to-day or even month-to-month stock market fluctuations are irrelevant assuming you have properly allocated assets into short-term instruments like cash, CD’s and short-term bonds. If your time horizon is long—e.g. you have a retirement account you won’t be tapping into for years—then how much the stock market swings in the near term is again irrelevant. What matters is dividend payments and price appreciation over years, not days, weeks or even months.
 
The best question around risk is not, “…what is your emotional tolerance for market volatility?” but rather, “…do you know what you   are doing?” If a professional money manager can’t tolerate short-term market movements—or guide clients to ignore such irrelevant events—he shouldn’t be in the business. Not knowing what you are doing is the primary source of risk for any undertaking whether it is investing in stocks, body surfing in the ocean, or caring for a sick child. Other true sources of risk include things like taking on excess leverage, being over-concentrated (having too much exposure to a given company or sector), and paying too much for a stock (purchasing a stock for far more than its intrinsic value).
 
Bottom line, when it comes to long-term investing (is there any other kind?), volatility is your friend, not your foe.
 
 
Taking Advantage of Volatility
 
While no investor can—nor do you need to be able to in order to create wealth via stocks over time— consistently predict short-term market movements, you can take advantage of them. At Coastwise we focus on owning high-quality dividend paying stocks and hedging them with conservative short calls when appropriate. So how does this investment approach take advantage of stock market volatility? Here are a couple key ways:
 
  • A well-diversified portfolio of dividend paying stocks may generate 100 or more dividend payments a year. This means that stock is consistently being purchased via reinvested dividends. When stock prices decline, a dividend paying portfolio naturally employs the powerful technique of dollar cost averaging. So not only are you buying more shares at lower prices, but those higher share counts in turn generate even larger dividend payments 90 days following. Thus, when you are a net investor via reinvested dividends, short-term volatility (in the form of price declines) actually works to your long-term advantage. This is not the case if you own just growth, or non-dividend paying stocks.
 
  • Options—which Coastwise generally sells as a means to hedge positions, generate income, or purchase a stock at a lower entry point—are priced based on a few variables, with overall volatility being an important one. As volatility rises, the price of options increases, and in turn the premium or income one can generate from selling options. Thus, not only do covered calls (the purchase of stock ‘long’ combined with the sale of a short call) provide some downside protection in a declining market, but volatile markets tend to allow the seller of calls to generate even more income than during calm markets. Specifically, if VIX (an important and now widely watched measure of volatility) increases as it did during certain events like the BREXIT vote last year, then option premiums get richer and one can earn higher income from option sales.
 
Political, economic, social, and other uncertainty can be unnerving. As humans we like to feel in control, we like the sensation of always ‘knowing’. But unpredictability is a reality of life, with the only question being to what degree. We have recently entered into what is likely a heightened period of uncertainty, and stock market volatility. Rather than fearing this, or being paralyzed by it (or worse yet selling long-term holdings until things become ‘clear’ again), look beyond the headlines to company fundamentals over the long term (your true stock holding time horizon). When you get away from incessantly changing headlines and focus on the long-term fundamentals, you will have a greater tendency to not take short-term action that could hurt your long-term finances. If you have the time and skill to take advantage of increased volatility—or can work with someone who has decades of experience navigating such waters—then so much the better. Let volatility be your ally not your foe; take advantage of it, don’t be the financial victim of ugly headlines and rapid market movements.
 
 
Here’s to a great 2017!
    Sincerely,

                        

                                                        
 
                                                            
 
Scott Kyle, CEO/Chief Investment Officer
 
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Coastwise Monthly Dividend Newsletter, April 2016

In honor of the Queen’s 90th birthday – as well as Prince’s death - this month’s Coastwise Dividend Newsletter is dedicated to royalty.

On Predicting Macro Economic Events and Their Effects on Stock Prices – The Little Prince

On April 17th, an announcement came out of Doha that no deal was reached on freezing, let alone reducing, oil production. Oil futures quickly plummeted and Asian equity markets dropped precipitously. US stock futures sank and it looked like Monday was going to be an ugly day on Wall Street (especially for oil/oil related stocks). The feeling that Sunday night in New York was akin to the nervousness associated with China’s currency devaluation last summer, which lead to a (temporary) stock market selloff.

And then oil rallied. Major oil companies (as represented by the XLE) spiked on Monday and have continued to go up despite most oil analysts predicting on April 18th that oil was headed straight to under $30 a barrel within weeks (it now trades near $45, approximately a 10% gain since the failed Doha talks).

If young Crown Prince Mohammed bin Salman himself had whispered in your ear on Sunday that no deal was to be reached and you made ‘logical’ oil related bets accordingly, you would have lost your shirt. In more than 30 years of investing and trading, I have seen countless occasions when either: 1) the macroeconomic news was entirely unexpected (jobs reports, inflation news, Fed decisions, etc.) and/or more importantly, 2) the market’s reaction was counter-intuitive.  There is a reason why Warren Buffett is on record saying he spends less than 5 minutes per year assessing macroeconomic news: it is the earnings of companies over time and how these earnings are valued which, along with the payment of dividends, lead to long-term appreciation. Spending time parsing every last word out of a Fed Chairman’s mouth may make for entertaining financial news, but it will not enhance your bank account in the years ahead. If the mother of all macroeconomic news - S&P’s first time ever downgrading of US Debt from its longstanding AAA rating in August 2011 (with a multi-year bond and stock market rally following) – was not enough to convince you to refocus your attention to corporate fundamentals/earnings (not constantly shifting macroeconomic events) then I am not sure what would.

King Dollar

The US dollar is the subject of much discussion in investment circles. A common argument is: “The US is totally screwed up, our political system is in shambles, we are becoming a 3rd rate country, the dollar is going down…” This assessment is partially true, but the premise behind it is often misguided. You need to look at the dollar in two ways: 1) as a store of value, and 2) as a currency relative to other currencies. Taking the latter first, many even very smart investors (Buffett included) have been predicting the decline in the value of the dollar relative to other currencies for many years, only to be proven wrong. For example, a few years ago €1 Euro could buy about $1.40 US, while today it can only buy around $1.13. The two currencies almost hit parity not long ago. The point here is that currencies strengthen and weaken relative to each other on an ongoing basis. To the surprise of many, the US dollar has been very strong the last half decade or so despite our exceedingly loose monetary policy. The US may be “screwed up” but many other countries are even more so, hence the relative strength. Trying to predict currency movements, let alone their impact on stock prices (many US based companies with overseas sales do their own currency hedging), is not necessary for the long-term wealth creation that owning a well-diversified basket of stocks can afford.

The aforementioned first aspect of the dollar, as a store of value, is crucial when it comes to investing. Often – especially during market sell offs – you will hear the comment that “cash is king.” Certainly in the near term to protect against (unpredictable) short-term stock market movements, or more to the point to have available to take advantage of lower prices when these inevitable declines occur, cash could be considered royalty. But over time cash holdings are nothing but paupers. When people state that the dollar is ‘terrible’, what they really are (or should be) referring to is the fact that held dollars have historically lost around 3% of their value per year due to inflation. For some long term perspective, a dollar held from 1802 to 2012 would have been worth less than 5 cents in real terms. One dollar worth of stocks in 1802 would be worth $704,997 in 2012 in real terms based on historical returns. Just for fun, $1 of gold in 1802 was worth $4.52 in 2012, and $1 in bonds worth $1,778. The power of long-term compounding comes through strongly in those figures.

Bringing the time frame to something more meaningful, a dollar held by a 50 year into retirement would be worth less than $0.50 by the time he/she had to start taking RMDs from an IRA. So if inflation is such a killer when it comes to the value of cash in our accounts then what are we to do? The answer is: hold a well-diversified basket of stocks, preferably a core holding of dividend paying stocks which are an excellent way to grow your money beyond that of inflation over time. “But aren’t stocks so volatile?” you ask. “Just look at the start of 2016....” Yes, in the near term, stocks can move up and down rapidly, but when you take a step back and see the forest rather than the trees – or more specifically assess volatility across your actual holding period which is years, not months or days - then the picture changes dramatically. Using Q1 2016 as an example, one could state it was extremely volatile. Many US stock indices entered bear market territory in February and several records for ‘worst start to a year’ were broken. If instead you looked at your January 1st statement and then your March 31st account balance (a whole 3 months!), you would have rightly concluded it was a tame first 90 days of the year, the market ending Q1 essentially where it started.

Bottom line, you should set your expectations such that periodic stock declines are not something you fear in your long-term journey of wealth creation. Interestingly, despite all the concrete empirical historical data showing how quickly stocks can recover from declines (the mid-February to the end of March 2016 period being just another in a long list of examples) our phones invariably ring far more when stocks are down then when they are up. While I have received countless calls over the years from investors expressing how much they are in fear (actual word used) over how their portfolio with a 15–25 year time horizon is doing today (during a market decline), I can’t remember the last time I received a call after a big rally with someone expressing fear over their stocks being overvalued.

All this brings me to someone who many in the investment world consider royalty, Warren Buffett. He states that the most important traits to being a great investor have nothing to do with your IQ nor mathematical skills. What makes an investor successful is emotional stability and patience. Someone with those characteristics would view what occurred in Q1 of 2016 as a non-event at worst, or at best an opportunity to invest more money at lower prices (many high quality blue chip stocks rallied 30% + off their February lows, e.g. big Buffett holding IBM increased from $116 to over $150 in under 30 trading days). Those lacking emotional stability and patience must arm themselves with means to keep themselves from self-financial harm. This is one of the greatest values a rational, long-term acting professional money manager can bring… to keep an investor from making short-term emotions based decisions that could harm his long term financial health.

Sincerely,

 

Scott Kyle, CEO/Chief Investment Officer

Coastwise Monthly Dividend Newsletter, March 2016

With the first two months of 2016 being characterized by heightened market volatility, I thought it would be a good time to review some basic investing tenets.  As always, we are here to answer any specific questions regarding your unique circumstances.

How to Survive a Bear Attack (An Ode to Leo)

  • Stay still.  Very still.  When it comes to stock ownership, often inaction is your best course of action.
  • Own dividend paying stocks.  Nearly half of all the S&P 500 returns have come from dividends over the last 40 years.  When you own high-quality dividend paying stocks, you can sleep at night knowing that at least about half your profits are secure.  Having a steady source of incoming cash also lessens your likelihood of selling your stocks at the wrong time.  During bear markets, dividend paying stocks tend to go down less than the overall market/than growth stocks with high P/E ratios.  To the extent you don’t need the income in the near term, the reinvestment of said dividends leads to more share ownership and higher future income – plus capital appreciation – once stocks recover.   From 1969 to 2014, the S&P 500 with reinvested dividends grew to over 4 times that of the same portfolio without dividends reinvested.  4X… that is eye opening.
  • Engage in things in life that take your mind off of what may be (but shouldn’t be) stress inducing day to day stock price movements.  Go workout, start a new hobby, call a friend, meditate.  Things that are positive for you and occupy your time will make you less inclined to track day to day market vacillations – and generally make you a happier person.
  • Review statistics around how long bear markets typically last – and compare this with your actual investment time horizon.   The average bear market lasts just over a year.  I’ve heard from investors who are 10 years from retirement (with a need for the money to work for them another 20+ years beyond their retirement date) express fear over near-term stock price declines – even though in reality by reinvesting dividends they will be financially better off in 10+ years by virtue of stock price declines today.  Be very realistic about your true investing time horizon.  Remember, a stock yielding 4% today can have an effective yield (income divided by original purchase price) of double digits in 10 years between reinvested dividends and annual dividend increases.
  • Review facts around how attempting to time the market statistically will likely make you poorer than if you maintain a disciplined approach.  There are countless studies showing empirically that the probability of attempting to time the market leading to far worse returns than holding a steady course is high – even for those who dedicate their lives to timing markets, let alone those who have professions outside of money management.

Why Dividends Matter and Why Increasing Dividends Count Even More

It is important to remember that the payment of a dividend is not necessarily a good thing, in and of itself. It is a taxable event for non-qualified accounts in which the company gives a piece of itself back to the investor to spend, invest elsewhere, or put back into the company paying the dividend, typically via a dividend reinvestment plan.

If, for example, a company is paying a $1 dividend and is trading at $50 per share, the stock will drop by $1 per share to $49 per share on the ex-date, barring additional market movement. Once the dividend is paid, the investor’s account contains $49 worth of stock and $1 worth of cash, the $1 distribution being taxable. Your $50 of stock before the dividend payment is now $49 of stock, $0.85 of cash and $0.15 in the pockets of the IRS for those in the 15% dividend tax bracket. Doesn’t sound like such a great deal now, does it? So why do you hear commentators praising dividends – in general terms, or the reinstatement thereof - as has been trumpeted lately for banks?

Clearly it is the company’s ability to pay - and keep paying - dividends that matters, since ultimately there is a direct correlation between ever-increasing dividends and ever-increasing earnings, the latter of which leads to ever-increasing stock prices over time. Management that knows it has to write a big check to shareholders every ninety days - and a bigger check every 365 days for those companies that consistently increase their annual dividend payments - will create a culture in which increasing earnings are a priority. In order to fulfill this mission, dividend-paying companies tend to outperform the market over time because management has this extra incentive to exercise financial discipline that favors stockholders. Cutting a dividend is paramount to admitting failure, and these companies have set their bars high.

Let’s look at the example of Boeing, Inc. (BA) as evidence of the long-term correlation between dividends, earnings, and stock price. Over the ten-year period from 2006 to 2015, BA increased its earnings at an average rate of about 10% per year. The annualized percentage gain in BA dividend over the same period? Surprise, surprise, just over 11%, from $1.20 per share in 2006 to $3.64 per share in 2015. (The payout ratio, or dividends divided by earnings, fluctuated but only exceeded 50% in one year and otherwise held steady in the 30% to 50% range). These figures show the strong, long-term correlation of earnings and dividend growth for companies which increase their dividends consistently over time.

Whether you need dividends to satisfy short-term expense needs or have a goal of material future income, dividend paying stocks - which both tend to outperform their non-dividend paying brethren while at the same time being less volatile - are a great core holding for any equity portfolio.

Sincerely,

 

Scott Kyle, CEO/Chief Investment Officer

Coastwise Monthly Dividend Newsletter, August 2015

2015 represents the 30th year I have been investing in stocks.  During those three decades, I have experienced every market condition from the crash of October 1987, to the excessive bull market of the late 1990s, to the Great Recession of 2008/2009.  There are some common lessons learned, in particular in response to inevitable market declines.  During times where it seems like the bad news will never end, it is important to take a step back to embrace a more objective, rational, perspective.

  •          Your investing time horizon is longer than you think.  The average wealthy person in the US can expect to live to approximately 80 years old.  That means a 65-year-old about to retire actually has a 10+ year expected time horizon for her IRA – and this assumes she spends every last dime during her lifetime, which most people do not.  Bottom line, investors typically vastly underestimate the length of time their money must work for them throughout their lives.
  •          You will never predict a market top or bottom – ever. The bull market that started in 2009 is (was) the 3rd longest in history.  Even smart financial commentators were calling for a bear market (20%+ market decline from peak to trough) for the last couple years.  When stocks dropped nearly 10% in a matter of days in October of last year, the “the end is here” crowd said it was the beginning of the end. Within the length of a short European vacation, the market rebounded double digits. That is not to say the current decline we are experiencing will be less in severity or duration – that is the point, no one will know until after the fact.
  •          Stock markets rebound from declines much faster than most investors realize.  Here are the number of months it took for the market to recover all of its ‘losses’ for the major declines in the last decade:
  •          Your total returns are not as correlated to short-term stock prices as you think.  Stocks historically have derived only about half their total returns from price appreciation. The other 50% of gains comes from dividends which get paid typically every 90 day regardless of near-term stock price movement.  Think about that: nearly half of your future returns will have little or nothing to do with stock price movements, let alone headlines about China or what the Fed will do in September or anything else along those lines. To the extent you reinvest dividends at lower prices during a near-term market decline, the future returns from dividends can easily exceed 50% of your total returns since buying more shares leads to even greater future dividends. How about other holdings you have?   Most bond returns are a function of interest and default rates, not short-term stock prices.  How about gold? While stocks lost nearly 50% from 2007–2009, gold went up 32%. From 1999 to 2002 when the DOW was down around 35%, gold gained about 16%.  During the bear (stock) market of 1972–1974, US stocks lost around 40% while gold was up triple digits. I am not here to say sell all your stocks and load up on gold, rather I am pointing out that to the extent you own any commodities/bonds/MLPs/or other asset classes in your portfolio, then you own things that are not necessarily directly correlated to US stock prices.

Examining 2008/2009, one of the largest declines in US stock market history, it took a short four years to recover losses, and this assumes you did not reinvest a single dividend.  However, most companies in the S&P 500 continued to pay, if not even increase, their dividends meaning that the time to recover a fully invested dividend paying stock portfolio was actually shorter than four years.  Further, if you were diversified into assets like bonds or gold, your peak to trough decline was less severe and your time to recover losses even shorter.  The bottom line here is that stock declines, while emotionally painful for some, have historically been short lived.

  •          Cash is not a good alternative to dividend paying stocks and other assets for building wealth over time.  In early March 2009 AT&T (T) bottomed out at just over $20 per share from around $40 at its peak in 2007.  As with the broad market, it took around 4 or 5 years for T to recover its pre-Great Recession price.  But what was happening to the better half of its profit source – dividends - during this time?  T, which currently yields around 5.6%, kept paying its dividends like clockwork every 90 days, actually increasing its dividend during this period.  In 2007 it paid $1.42 per share, in 2008 $1.60, in 2009 $1.64… fast forward to 2014 and the annual payment was $1.84 per share.  If you bought T at the very worst time and held, reinvesting dividends, your effective yield – your income based on your purchase price – would be over 10% a few short years later.  The cumulative income from T over that period was well in excess of 20% compared to cash earning 0%.  You need your money to work for you in retirement.  For those who panicked and sold at lows in 2009, they locked in losses and have only seen their purchasing power decline by 2–3% a year to inflation.  For those who recognized that their time horizon was longer than a few days or months or even years, and who maintained a disciplined approach to their investing rather than letting minute-by-minute (“BREAKING NEWS!”) mass market media driven headlines dictate their personal long-term investment plan, they came out of one of the worst financial crisis not only unscathed, but better for the wear. 

It happens every time.  A bull market gets long in the tooth, financial pundits predict daily that a crash is around the corner, and for years it does not happen.  Then when it does, it hits fast and furious - the Dow had barely budged throughout 2015 and then dropped over 2,000 points in a few trading days.  Yet everyone is ‘shocked’ that the market actually declined, as if an alien just landed on the White House lawn.  Before you take any action, ask yourself these questions: What is my true investment time horizon, not my emotional one? Have I or anyone I know ever consistently predicted market tops and bottoms?  When I look back at the financial crisis of 2008/2009, do I wish I sold all my stocks (or if I did, am I glad I did?) or was it actually a good time to buy – or do nothing?  Have I ever made a good life decision in a state of high emotion? Do I own income paying securities and do I think they will continue to send me checks in the years to come?  Is my bank account going to start paying me 3 or 4% on my savings/checking account any time soon (or even 1%)?  What would have happened if I just ignored all the news, all the financial pundits, and stuck to my long term disciplined investment program in 2008/2009?  Answering these questions objectively and without emotion will lead to prudent decisions that could affect your financial future 5+ years from now.

Sincerely,

Scott Kyle, CEO/Chief Investment Officer

Coastwise’s financial advisor, Laurie Itkin, appears on Fox News to discuss the wild swings of the stock market.

Coastwise’s financial advisor, Laurie Itkin, appears on Fox News to discuss the wild swings of the stock market.

http://ow.ly/RwbWX

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